The Stock Drop is a Correction, not a Comment

The Stock Drop is a Correction, not a Comment

A drop of about two percent in US stocks followed major developments in a crisis in Washington, DC, but that doesn't necessarily mean that the latter caused the former. Despite the headlines, the drop is a routine correction.

By Vikram RangalaThursday, May 18, 2017 - 00:00

Correction (fluid) | Getty Images

While the headlines about Wednesday's drop in the markets frequently referred to the president or to several overlapping crises and controversies, it is important not to begin trading the news. What does "trading the news" mean? It means trying to predict what the stock market will do in reaction to the next shocking piece of news in the ongoing political turmoil.

With the appointment of a special counsel to investigate connections between Russia and the Trump campaign, the crisis in Washington became more serious. The fact that the person appointed is none other than James Comey's predecessor as FBI director, Robert Mueller, makes it even more likely that a thorough investigation will proceed and continue to dominate headlines in 2017. And since stocks also dropped in the 3 days following the firing of Comey, it's easy to believe that the market was reacting to that news.

However, the market recovered from that drop, which incidentally was a precise 38.2% Fibonacci retracement from the monthly high. Was the market changing its mind? No. It was buying back stocks at lower prices, plain and simple. While it's true that Wall Street is concerned about policy (particulary tax policy), this recent selloff in stocks is not political commentary by investors.

That's not to say that the markets are independent of the rest of the world. It's just important to recognize that multiple factors are at work and only some of them show up in headlines. Others may be known only to industry professionals—though there aren't as many insider secrets as some people think. However, the net result of all those forces is always in plain view of anyone who cares to look: it's on the price chart.

Basic technical analysis using Fibonacci retracements gives us a sense of how this week's stock "drop," "plummet," or, if you prefer, "tumble" fits into the big picture. We've magnified it so you don't have to squint: it's that red blip at the right end. It has dropped to levels seen about three weeks ago, which is roughly a 61.8% retracement from the two-month high.

And if we zoom out to look at the entire post-election rally, it hasn't even reached the 23.6% level, which it touched twice in the past two months. That rally has been called the Trump Rally by many. This is not meant as a political remark, but the numbers clearly show that, whatever the headlines, it's too early to say that the Trump Rally is over or has given way to a Trump Correction.

If Wall Street is really troubled by any aspect of the crisis which the special prosecutor will now investigate, it's this: tax cuts will be harder to pass in 2017, particularly the tax cuts for corporations which many believe would cause a short-term boost in corporate profits and stock prices. If those cuts don't make it into a 2017 bill or budget, they will be harder for Republicans to pass in 2018, an election year. And if the Republicans lose their majority in the House in 2018, getting tax cuts for wealthy corporations passed in 2019 will be virtually impossible.

The policy groups headed by billionaire brothers Charles and David Koch plan a multimillion-dollar advocacy campaign to get tax cuts passed this year along the lines the president has spoken about. But after the failure to pass a true repeal of Obamacare, many executives and analysts at financial institutions are lowering their expectations. Headlines on Politico.com have gone from "Wall Street bets on tax cuts" on March 14 to "Wall Street unimpressed by Trump tax plan" on April 26 to Wednesday's "Wall Street gives up on a 2017 tax overhaul."

When stocks (or any market) are in a sideways channel just below highs, it's better to trade the short-term movements with limited risk, the way you can on Nadex, than to speculate about whether and when the market is going to break upward or come down past support. Yes, the drop yesterday was a relatively big one, but it stopped at support and didn't come close to the bottom of the recent range. This correction was entirely within parameters. In other words, it was a great day to sell binary options on each down move and even to buy at the bounces off support.

Wasn't it also a clear sign that the market is finally giving up on the Trump Rally and going into a pessimistic downward spiral? Look at the chart for your answer. The low of the Dow Jones Industrial Average on March 14 was about 20720. And on May 17, around the "gives up" article was published, the Dow was trading at about 20720. So much for trading the news.

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